Fractional Reserve Banking as Economic Parasitism (2002)

Fractional Reserve Banking as Economic Parasitism

A Scientific, Mathematical, & Historical Expos´e, Critique, and Manifesto

Vladimir Z. Nuri

vznuri@yahoo.com

Abstract

This paper looks at the history of money and its mod-ern form from a scientiﬁc and mathematical point of view. The approach here is to emphasize simplicity.A straightforward model and algebraic formula for alarge economy analogous to the ideal gas law of ther-modynamics is proposed. It may be something like anew

F

=

ma

rule of the emerging econophysics field.Some implications of the equation are outlined, de-rived, and proved. The phenomena of counterfeiting,inflation and deflation are analyzed for interrelations.Analogies of the economy to an ecosystem or energysystem are advanced. The fundamental legitimacyof “expansion of the money supply” in particular isre-examined and challenged. From the hypothesesa major (admittedly radical) conclusion is that themodern international “fractional reserve banking sys-tem” is actually equivalent to

legalized economic par-asitism by private bankers.

This is the case because,contrary to conventional wisdom, the proceeds of in-ﬂation are not actually spendable by the state. Alsopossible are forms of “economic warfare” based onthe principles. Alternative systems are proposed toremediate this catastrophic ﬂaw.

1 introduction

“An invasion of armies can be resisted, butnot an idea whose time has come.”

—Victor Hugo

The dynamics of money is an extremely complicatedsubject. It’s a foremost preoccupation of humans,as in the way money system mechanics is intricatelywoven into major plotlines of complex and inﬂuentialpopular ﬁction works such as Rand’s

Atlas Shrugged

[52] or Stephenson’s

Cryptonomicon

[61]. Extrapo-lated, it even becomes a “social energy system” themein more futuristic or outlandish forms such as emerg-ing from the popular science ﬁction movie

The Ma-trix.

Possibly the full leverage of focused worldwide sci-entific inquiry and attention has yet to be appliedto economics. Some evidence that the science isstill in its infancy are that new fields of “economicphysics” or “econophysics,” “computational finance,”also dubbed “phynance,” have been proposed onlyrecently.[4, 19, 18] Physicists are applying statisti-cal and computational modelling techniques to comeup with creative,

ad hoc,

or highly realistic theoriesof money ﬂow in

e.g.

large economies or stock mar-kets.[20] Despite the overused cliché, objective scien-tific commentators sensitive to these kinds of shiftsand trends could easily identify all the signs of anapparent Kuhnian “paradigm shift”[38] in progress.So the blaring headlines read, “Physicists try tobreak economists’ monopoly on financial theory”[4]and “Physicists attempt to scale the ivory towers of finance.”[19]One major factor in the shift is increased compu-tational power due to the so-far-uninterrupted real-ization of Moore’s law over about four decades at theclose of the 20th century,

i.e.

exponential growth (ingates per chip or many other similar measurements).This awesome and accessible power has elevated thecomputer to the status of a new scientiﬁc instrument,roughly analogous to the invention of the microscope1

or telescope, which has rapidly transformed conven-tional scientiﬁc perspectives on laws of both natureand societies.

Complexity

is the buzzword across multiple disci-plines, even as previously segregrated disciplines aremarried [12, 66] (

e.g.

in the case here, physics, ﬁ-nance, biology, thermodynamics,

etc.

). It is likely keyinsights have not yet been totally realized, remainingpotential lying undeveloped. For example, virtuallyall economic theory of the 20th century was devel-oped largely

without

extensive computational exper-iments, modelling, simulations, and empirical analy-sis, so central to the new style of inquiry

via

the pre-miere, even transcendental instrument(s) of science—the computer and the algorithm.[13, 5]The new breed of econophysicists are very open-minded in their metaphors, borrowing seemingly al-most indiscriminately (leaving them open to one of the major but predictable criticisms). A particularnew meme receiving heavy attention and advance-ment is the metaphor of the

economy as an ecosystem

.Such a view seems obvious in retrospect of various re-search delineating the parallels, but it was unfamiliar,novel, and even somewhat radical when ﬁrst exhaus-tively and deﬁnitively proposed by

e.g.

Rothschild inthe seminal and foresightful book

Bionomics: Econ-omy as Ecosystem.

[55] It was not clear initially if the idea was just another shallow fad not so muchwith scientiﬁc merit but to be mostly appropriatedby those seeking to justify ulterior political or socialagendas.[7]However, subsequent quantitative research, now afull decade after Rothschild’s manifesto, has pushedthe metaphor into reality and signiﬁcantly strength-ened the case for its validity and correctness. Asa Wall Street Journal reviewer wrote, used as thefront-cover blurb for the book, “Revolutionary... afascinating and highly creative alternative to the wayconventional economics views the world.” The early

tour de force

analysis by Farmer, “Market force, ecol-ogy, and evolution”[20] invokes and reapplies theimportant Lotka-Volterra differential equations orig-inally proposed for modelling population dynamicsto a stock market system (see Farmer’s work for anexcellent survey of the economy-as-ecosystem memethread in the scientific literature).As usual with a paradigm shift, the perspectiveflip-flops. How can the economy possibly

not

bethought of as an ecosystem? In Farmer’s work, dif-ferent traders’ strategies are ﬂuctuating adaptationsanalogous to evolutionary niches occupied by variousorganisms. The Lotka-Volterra equations originallyintroduced to explain oscillations in populations withpredator-prey relationships map readily into describ-ing capital (money) gains associated with the com-petitive speculative strategies utilized by inter- andindependent traders.The analysis presented here will be heavily depen-dent in places on the economy-as-ecosystem conceptand mostly take it as unequivocally justiﬁed and vir-tually proven, even though it is not a common per-spective among mainstream economists, and the un-derlying research agenda is clearly only beginning.Nevertheless, building on it, an important additionaltheme proposed and explored here is that of

economicparasitism.

Along these lines, another paradigm shift is go-ing on in the ﬁeld of parasitology. Researchers areonly recently beginning to appreciate the full implica-tions of parasites in and on ecosystems,

via

similarlyboundary-crossing interdisciplinary scientiﬁc collab-orations, all forcing a serious re-evaluation of the“big picture.”[70] In fact the study of biology is inmany ways the study of parasites; by one estimate, onplanet earth parasites outnumber ‘freeliving’ species

four to one!

New realizations are manifesting around the ubiq-uitous and crucial role(s) that parasites play inecosystems. In many ecosystems parasites are farfrom inconsequential, insigniﬁcant, or innocuousstowaways, but in actuality, despite their relativephysical and scientiﬁc invisibility,

drive

entire ecosys-tems. Parasites have been

a

domininant force, andmaybe even

the

dominant force in the evolution of life![70] So... given their forefront role, what is thepresumable link to economics?The third major theme pursued here in naturalconjunction with bionomics and parasitism is a largescale economy seen as an

energy system.

While againthis concept may seem obvious, the full understand-ing stemming from this perspective appears not yetavailable. There is a strong parallel between eco-2

nomics equations and

e

.g. thermodynamics or elec-tronics formulas that does not seem to have beenexplored systematically by researchers so far. More-over, if the economy is an energy system, then vari-ous laws governing it can be analyzed and regulatedbased on solid engineering principles, and the mys-tery of economic dynamics should be minimized in

e

.g. the same way engineers understand the construc-tion of buildings based on applying Newton’s law.So far econophysicists have tended to focus onthe dynamics of markets. However it is possibly in-evitable that they will soon arrive at a reconsidera-tion of the classic questions of economics, one of thechief ones being the question of the optimal policy for

expansion or contraction of the money supply

. Hope-fully new scientiﬁc light can be shed on this age-oldquestion and deﬁnitive rather than speculative an-swers are within reach. This paper has been writtenwith that main goal in mind.

2 brief history of money

adult:

Our government borrows money ev-ery year.

child:

Where does the money come from?How can we always be in debt and nothave to pay it oﬀ?

adult:

We’re in debt to ourselves.

child:

That doesn’t make any sense!

adult:

It’s based on fractional reserve bank-ing. Banks do not have to have all themoney that they lend.

child:

I still don’t understand.

adult:

You’ll understand it when you getolder.Paper money was not used by Europeans until themiddle ages, partly on the discovery of its success-ful use in China by Marco Polo in the 13th century.The Greeks and Romans used coins. Some standardterminology is useful: (see

e.g.

[32] or [50])

commodity money

Money that is made out of acommodity

e.g.

typically a precious metal, ei-ther gold or silver,

i.e.

coins.

receipt money

This is also called “fully backedcommodity money” in [50]. A goldsmith orbanker issues paper receipts or certiﬁcates al-ways redeemable for an exact quantity of pre-cious metal and the receipts may be traded in-dependently.

fractional money

Money that is backed by a com-modity only at a fraction of the face value. Alsocalled “fractionally backed commodity money”in [50]. Also called “bank money” or “bookcredit” in [17]. For purposes here, the exact frac-tion is considered to be ﬁxed in perpetuity.

ﬁat money

Money that is declared “legal tender”by a government with no commodity backing.Or for purposes here, arbitrary manipulationrather than ﬁxed commitment to any fractionof backing.

paper money

For purposes here, money made outof paper. Depending on backing it could be ei-ther receipt, fractional, or ﬁat money. Many au-thors use it as a synonym for fractional or ﬁatmoney to contrast it with commodity money.

electronic money

For purposes here, money as re-duced to an abstract accounting process in-volving ‘blips,’ no longer requiring a physicalmedium for transfer. Also called “digital cash”or “cybercash.” Depending on backing it couldbe either receipt, fractional, or ﬁat money.As

e.g.

Griffin [32] and Rothbard [54] explain, re-ceipt money was often turned into fractional moneyby bankers. They found they could temporarily loanout additional pseudo-certificates exceeding their col-lected inventory of gold and collect interest on theseloans. Rothbard notes that this practice was ruled le-gal by courts in some historical cases. Griffin assertsthis practice invariably leads to an inherently unsta-ble money system and periodic runs on banks, withmany historical examples to make his case. Griffinalso asserts that fiat money always leads to hyper-inflation and worthless currency. These views willbe carefully reappraised here with slightly differentconclusions.3